The Effect of an Introduction of Retail Sales Tax in China^*

This paper develops a dynamic equilibrium model of overlapping generations to study the effect of an introduction of a retail sales tax (RST) in China. Total government tax revenue is fixed, consumption-type value-added tax (VAT) is reduced in response to the introduction of RST, and an output tax exists. An introduction of RST accompanied by a decrease in VAT increases capital accumulation and welfare in the steady state. In the transition period, an introduction of RST accompanied by a decrease in VAT increases capital accumulation but decreases the current generation's welfare. Simulations based on the data from China show that introducing an 8 percent RST increases capital accumulation by 0.43 percent in the steady state.